How much risk capital should one use in a single trade?
- Thread starter OddTrader
- Start date
From my experience, the max DD pain is generally about half what a person says or thinks it is. Also if you are going to make a mistake in sizing, it is better to mistakenly trade too small than too big.
Also, you have to account for degradation of returns - strategy obsolescence, human error, lack of opportunities during an unfavourable market environment etc.
For this reason, I think it's best for all traders to aim for a 1% chance of a 10% drawdown each year*. In the real world, with various assumption errors and implementation errors, this will probably equate to about a 1% chance of a 20% drawdown. And most people can handle 10% relatively easily, and 20% in a shit hits the fan situation. So if you target 99% confidence of <10% drawdown, your worst case scenario would be a bit painful but definitely survivable.
It also has the welcome side-effect of ZERO trading stress and size-related dilemmas, and improves your ability to withstand hard market tests or grey swans - and in fact means you have both the financial and psychological reserves to add some risk during those periods. This actually boosts returns through selective opportunism. Also it reduces to nil the chance of a 'death spiral' of losses causing psychological 'tilt', which radically increases the risk of further and bigger losses; same with investor redemptions.
This both reduces risk even more than the halving of size would by itself, and improves returns per unit risk by adding staying power and opportunism/reserves. You may well actually end up with performance only about 25% lower (i.e. 15% a year instead of 20% a year) and with risk of about 1/3 of your original level (e.g. 7% instead of 20% drawdowns), for a *doubling* of the CAGR/DD ratio - a gigantic improvement for an entirely trivial adjustment that ANY trader or institution can make with about 60 seconds work.
* I realise almost no one follows this, even myself. Although this post has made me think about it more.
Quote from OddTrader:
Hello folks
How much risk capital should one use in a single trade?
Should it be 5%,10%, 25%, 50%, 75% or even 100% from the risk capital?
What do you think?
I thing that the market is so predictable (however still with certain uncertainty), that one mustn't risk less than 50%. This should stay between 50%, 75% and max 100%. Otherwise one can get hurt (opportunity cost/profit) quite heavily.
So, what do you think?
100% is the answer.
Remember: no guts, no glory.
How much capital in one trade?
Well... when I enter in a trade I ask to myself a different question...
How much money I'm ready to lose in this trade if it goes wrong?
My answer is... little. Max 1% of my trading account.
In other terms I do oppostite.... I observe how meny PIPs I need in stop loss for my set up. Than I calculate the size in a way that stop loss is max 1% of trading account.
Example: if my trading account is 50 K â¬. 1% is 500 â¬. I do not want to risk more than 500 ⬠in a single trade. If for example I need 20 PIP stop loss for my technical set up, I nead each PIP not to be more than 25 â¬.
Now in EUR/USD 1 standard contract (100.000 units) 1 pip is around 8 â¬.
Than I cannot enter with more than 3 contracts.
Ok this is a little semplified but it is how I think about this matter. You in reality should also take into consideration the spread of the broker and also to be sure not to have positions that have the same risk exposure... meaning co related position. In fact if you are long both of EUR/USD and of GBP/USD than you need to sum both your stopp loss and your risk as the 2 cross have got strong positive correlation...
Well... when I enter in a trade I ask to myself a different question...
How much money I'm ready to lose in this trade if it goes wrong?
My answer is... little. Max 1% of my trading account.
In other terms I do oppostite.... I observe how meny PIPs I need in stop loss for my set up. Than I calculate the size in a way that stop loss is max 1% of trading account.
Example: if my trading account is 50 K â¬. 1% is 500 â¬. I do not want to risk more than 500 ⬠in a single trade. If for example I need 20 PIP stop loss for my technical set up, I nead each PIP not to be more than 25 â¬.
Now in EUR/USD 1 standard contract (100.000 units) 1 pip is around 8 â¬.
Than I cannot enter with more than 3 contracts.
Ok this is a little semplified but it is how I think about this matter. You in reality should also take into consideration the spread of the broker and also to be sure not to have positions that have the same risk exposure... meaning co related position. In fact if you are long both of EUR/USD and of GBP/USD than you need to sum both your stopp loss and your risk as the 2 cross have got strong positive correlation...
why not decide on how long u gonna hold? then decide on the stop? obviously if u have little capital u cannot hold long, if u got slightly more, u able to hold longer and that forms your stop. if u gonna calcuallte percentage of your capital, u end up being losing because u need to determine how long you can hold.
Agree. Modify your time frames to suit your stop loss. Don't think of eating daily profits when your stop is of 15 mins.
Good point about the correlation. It's no fun watching all your positions going South at the same time.
In addition to the risk per trade, I also set a maximum number of positions I can have on at any one time (ie. allocation of capital) and ensure they are spread out across a variety of instruments. I avoid having everything in equities alone, as an example.
To be clear I am a swing trader so I hold for longer periods, making this all the more important.